The biggest bond market in the world is 'distorted'

With the US nearing full employment and wage pressure growing,
expectations are rising that the Federal Reserve will raise
interest rates as soon as this month.

Usually, an improving US economy that's witnessing both a return
to full
employment and
inflation nearing the Fed's 2% target is accompanied by
a steepening yield curve in the US Treasury market, the biggest
bond market in the world. A steepening yield-curve is
technically explained as long-term yields rising more
quickly than short term yields — because when things are looking
good, and there's lots of healthy opportunities for
investment, investors demand more in return for tying up
their capital for long periods.

But that's not what's going on this time around.

A quick look at the 2-year/10-year spread shows the yield
curve has actually been tightening ever since the
Fed began tapering
its asset purchases at the end of 2013. In fact, the yield
curve is down to 92 basis points and at its flattest level since
2007.

Business
Insider / Andy Kiersz, Data from Bloomberg

While this goes against textbook economics, Deutsche Bank's
chief international Economist Torsten Sløk says there's a simple
explanation for what's taking place. He included this
chart his monthly US Economic Outlook. The more red a
country is, the higher percentage of its bonds have a negative
yield.

Deutsche Bank

Notice how the US isn't on the chart. And that's exactly the
reason why the US yield curve is flattening. As money managers
look around the world for yield they find there's not a lot out
there. Sløk told Business Insider:

The ongoing global hunt for yield is having a significant
impact on US interest rates. Specifically, the US yield
curve is distorted because of negative interest rates in Europe
and Japan creating a significant inflow of money into US
Treasuries, not driven by the outlook for the US economy and US
inflation but driven by the weak outlook for growth in the rest
of the world.

As the Fed continues to hike rates the yield curve is likely to
flatten further as interest rate differentials with the rest of
the world grow. This suggests an inverted yield curve may not
signal a recession like it used to.